I had a friend who sms me 2 days ago whether getting an ILP for investment is good. It seems that with the market flourishing, I have many friends coming to seek my advice on this.

They do have to realize before even talking about gains, they have to be clear about the objectives they wanna achieve. If its investment, what is it for? and how long they have to when they wanna take the money out. Simple questions but if you don’t ask, you may be buying something just on impulse.

One thing i realize is that the financial adviser recommending him stuff like that should have made sure he understands this before recommending ilp to him. I am not a certified financial planner, thus my advice to him is to assess how competent is this adviser. The Straits Times this Sunday came up with a list of questions to pose your agent. It does not encompass every aspect, but nevertheless its a good list.

Here is a checklist from Straits Times invest section on questions that you can pose a prospective insurance agent:

What services can you provide? Find out if the adviser offers cost-effective solutions from multiple product providers or if the products he recommends are restricted to one source. Some consumers feel safer with advisers and products from large well-known institutions. Others may want to deal with advisers that offer a wider choice of products.

Who else could benefit from your recommendations? An adviser who promotes insurance, unit trusts and stocks may have seperate tie-ups with the firms that supply these products. He may also have other business relationships that should be disclosed to you. This includes income he receives for referring you to an insurance agent, an accountant or a lawyer in relation to recommendations that he makes to you.

What are the risks and disclaimers? Don’t hesitate to ask the adviser to highlight any risks, potential downside or restrictions that may apply to the product he is recommending. Ms Wendy Lee, 40, suffered a rude shock when she realised, after her divorce, that she was unable to change the person who would be a beneficiary of her life insurance policy. She was not told at the point of sale that an “irrevocable statutory trust” is created – under Section 73 of the Conveyancing & Law of Property Act – for the spouse and/or children when they are named as beneficiaries in a policy. In simple terms, that means her ex-husband is entitled to the insurance proceeds because he was named as the beneficiary when the policy was taken out. Even having a will does not change the situation.

How do I pay for your services? Payment can take several forms.

Commissions paid by a third party for the sale of products. These are usually a percentage of the amount you invest in a product.

Fees based on a percentage of the assets you invest.

A combination of fees and commissions. Fees are charged for the amount of work done to develop financial advisory recommendations and commissions are received from any products sold. Some planners may offset a portion of the fees you pay if they receive commissions when you buy products they recommend.

A salary paid by the firm for which the adviser works. The advisor’s employer receives a payment from you or others, either in the form of fees or commissions, in order to pay the planner’s salary.

What commissions do you earn? Don’t be afraid to ask the exact commission amount that the adviser will earn from the sale. For instance, the commission for a regular premium investment-linked plan can be as high as 50 percent in the first year, before dropping to 25 percent in the second year, 10 percent in the third year, and 5 percent each in the forth, fifth and sixth policy years. This means that if the annual premium is $50,000, the first-year commission earned by the adviser is a substantial $25,000. For a single premium investment-linked plan, the one-time commission is typically a much smaller 2 percent to 3 percent. In the case of hospitalization Shield plans, some generate first-year and renewal commissions of up to a 25% percent and net premiums of 15 percent for the adviser, as long as the plan stays in force.

What experience do you have? You have a right to be nosy. Find out the adviser’s experience and the number and types of firms which he has been associated with. Some experts advise consumers to choose an adviser with at least 3 years of experience in providing financial advice.

What qualifications do you have? Ask the adviser what qualifies him to offer financial advice and whether he holds or has held any financial planning designation. If the answer is yes, check on his background with the respective organization.

Can i have it in writing? Ask the adviser to put in writing the services he has provided and the recommendations he has made. Keep this document for future reference.

At the end of the day, ask for a list of documents for recommending that product to you. These include:

A summary of your financial information such as investment objectives, current financial situation and personal needs.

Recommendations made by the adviser and the basis for making these recommendations.

A copy of the benefit illustration and product summary for insurance products.

A copy of the prospectus for unit trusts.

The name of the firm he represents and the type of advisory service he is licensed to provide.

At the end of the day, after asking all these questions, there are still room where the adviser can play you out. Governance can only do this much but it is whether you are fated to meet such a good adviser.

I do have much to gripe about my current 2 advisers that i am being serviced but i will leave that to another day.

Most of you have seen the nifty retirement software available from the likes of Vanguard and T. Rowe Price which provides the mathematical muscle to help you plan your retirement. Input your retirement age, expected lifespan, required annual income, rate of inflation and investment return, and hey presto, you find out that to avoid a golden years diet of Alpo you need the GDP of the average Central American republic.

Problem is, it may quite possibly be worse than that. These calculators all make the same erroneous assumption — that your expected rate of return is the same each and every year. In other words, let’s assume that the real (inflation adjusted ) rate of return of the S&P 500 will be 7% in the future. You might conclude that you can withdraw an inflation adjusted $70,000 of your $1,000,000 Vanguard Index Trust 500 IRA each and every year indefinitely, and maintain yourself with the same real income in the long run. And you’d be wrong.

It turns out that if you have rotten returns in the first decade you will run out of money long before reversion to the mean saves your bacon in later years. To illustrate this phenomenon I went back to good old Uncle Fred’s infamous coin toss, with its return of either -10% or +30%. Let’s assume that these represent real returns. If over 30 years you toss 15 heads and 15 tails you earn a compounded rate of 8.17%. (If you don’t understand why you don’t earn the average return of 10% (the average of -10 and +30), then go back and read Chapter One of The Intelligent Asset Allocator.) If you start with a $1,000,000 portfolio and roll alternating heads and tails over the 30 year period, then you indeed can withdraw $81,700 (8.17% of the initial amount) over the next 30 years before all the money runs out. However, if you are unlucky enough to roll 15 straight tails before rolling 15 straight heads, you can withdraw only $18,600 per year. Reverse the process and roll the 15 heads followed by 15 tails, and you can withdraw $248,600 per year.

This phenomenon was first brought to the attention of the investing public by Philip L. Cooley, Carl M. Hubbard, and Daniel T. Walz from Trinity University. They looked at the “success rate” of various withdrawal strategies over numerous historical periods, and came to the conclusion that only a withdrawal rate of 4%-5% of the initial portfolio value (i.e., $40,000-$50,000 of a $1,000,000 portfolio) had a reasonable expectation of success. This article can be found in the February 1998 AAII Journal. You can also obtain a lucid explanation of their work as well as their “success tables” on Scott Burns’ excellent website.

Larry Swedroe has established a reputation as one of the clearest thinkers and best writers in the field of passive investing. Swedroe is the author of many books, including Wise Investing Made Simple: Tales To Enrich Your Fortune, which hit the bookstands last Monday.

“Larry has written some of the most sensibly and clearly written books anywhere for sophisticated passive investors,” said Jim Wiandt, publisher of IndexUniverse.com and the Journal of Indexes. “Now he has one-upped himself by writing the book we’ve always wanted to give to our friends, relatives and clients when they ask us for tips. With a fireside chat manner, Larry goes through a wide array of complex financial ideas by explaining them clearly through stories. I found the book to be thoroughly entertaining. And investing novices will find it to be invaluable.”

Swedroe spoke recently with IndexUniverse.com editor Matt Hougan about the new book and, more broadly, about his overall investing philosophy.

IndexUniverse.com: Tell us a little bit about the new book, and why you wrote it.

Larry Swedroe (Swedroe): The book tries to take a topic that a lot of people are scared of—money and investing—and bring it into the real world and make it simple and easy to understand by using stories … stories about sports, about family, about the things that aren’t scary. Because the basic concepts are easy to understand, and if you can get people to understand just a few key concepts, they’re going to be much better off in the long run. Most people remember stories more readily than a complicated chart.

IndexUniverse.com: Give me an example.

Swedroe: Well, I’ve found that the best way to teach people about investing is to tie it to the idea of betting on sports. Many people understand betting on sports, and not enough people understand investing. So one of the stories I use in the book is this …

Even someone who doesn’t know much about college football would recognize the answer to this question: If the University of Texas, a national contender for the championship every year, played a school called San Angelo State, which team is likely to win?

Easy, right? If they play 100 times, Texas would almost certainly win 100 of those games.

The problem is, if you’re trying to make money betting on Texas, you can’t do it. To make money, you might have to give the other team a 40-point spread.

As it turns out, the point spread is an unbiased estimator of the outcome. Even though a bunch of amateurs set the point spread by their betting actions, the favorites tend to win by more than the point spread half the time, and less than the point spread half the time. So it’s very difficult to make money betting on sports; the only people likely to make money are the bookies.

How does that tie to investing? Well, ask yourself the question: If you consider two companies, GE and Ford, you know that GE is the better company. But should you invest in GE just because it’s a better company? No, you have to pay a much higher price for GE than you do for Ford … the price-to-earnings ratio makes both of them equally good investments once you adjust for risk, the same way the point spread gives you an equal chance to win. In other words, GE is Texas and Ford is San Angelo State. Just as the point spread equalizes the risks of betting on either team, the difference in the P/E ratio makes both companies equal investments once we adjust for risk.

Most stockbrokers are nothing more than bookies. They just need you to play—to buy and sell stocks—and they pocket the commission. They win. You don’t win by playing their game. That’s why the bookies own the yachts, when it should be the investors that own the yachts.

I use stories like that one throughout my book to break down the myths about investing, to make it clear. Because stories are the easiest way to get people to learn.

If you tell somebody a fact, they’ll learn. If you tell them a truth, they’ll believe. If you tell them a story, it will live in their hearts forever.

IndexUniverse.com: Do you think younger investors with a longer time horizon should hold more small-caps, more international and more value exposure than the broad market? That seems to be the thinking among a lot of the DFA-inspired crowd. Swedroe: Let’s begin by addressing this question: Why should anybody at all deviate from a market-cap-weighted strategy?

The answer begins by understanding that there isn’t one factor that determines equity returns. That’s what people used to believe—the more exposure to beta you had, the higher your expected returns and risk. But along came Eugene Fama and Kenneth French. They demonstrated that a three-factor model explains returns much better than the one-factor model. Beta explains about two-thirds of returns while the three-factor model explains about 95% of returns. And unfortunately, prior beta does not determine future beta.[Read more…]

Sun Tzu is an honorific title bestowed upon S?n W?. Tzu, who lived from 544 to 496 BCE, authored The Art of War, an immensely influential ancient Chinese book on military strategy. The book, composed of thirteen chapters, each devoted to one aspect of military warfare, has long been considered one of the definitive works on miltary strategies. It has also had a huge influence on business tactics. Investors can also benefit from its wisdom. They can particular benefit from the insight provided by one its most often cited phrases: “Every battle is won before it is ever fought.”

On July 19, 2007, the S&P 500 Index closed at 1553. By August 15, it had fallen to 1407, a drop of almost 10 percent in less than a month. The drop was fueled by a flight-to-quality, or what might be called a flight-to-liquidity. Headlines from the financial media reported huge losses in hedge funds as investors fled all risky assets, the kind of assets hedge funds often buy.

The media (and not just the financial media) also commented about how this was an unprecedented event. The following statement is a good example. It was made by Matthew Rothman, global head of quantitative equity strategies for Lehman Holdings Inc. and a University of Chicago Ph.D. After three days of huge losses for equities all around the globe Rothman stated: “Wednesday is the type of day people will remember in quant-land for a very long time. Events that models only predicted would happen once in 10,000 years happened every day for three days.”1

Lehman’s models (as well as the models of many other hedge funds) may have made such a forecast, but all that proved was that the models were wrong. These events have occurred in the past, and they have done so with a fair amount of frequency. In fact, we had a very similar crisis in the summer of 1998, just ten years earlier.

The hedge fund Long-Term Capital Management (LTCM) was founded in 1994 by John Meriwether (former vice-chairman and head of bond trading at Salomon Brothers). Myron Scholes and Robert Merton, who shared the 1997 Nobel Memorial Prize in Economics, sat on its board. LTCM had early successes producing annualized returns of over 40 percent in its first years. Then, in 1998, it lost $4.6 billion in less than four months and became the most popular example of the risk that exists in the hedge fund industry. In early 2000, the fund folded. LTCM, failed because its models told them the same thing that Rothman’s model had told him. As Spanish philosopher Santayana warned: “Those that cannot remember the past are doomed to repeat it.”

The Historical Evidence

Professor Eugene Fama (the thesis advisor to LTCM’s Myron Scholes at the University of Chicago) studied the historical distribution of stock returns. Here is what Fama found: “If the population of price changes is strictly normal, on the average for any stock…an observation that is more than five standard deviations from the mean should be observed about once every 7,000 years. In fact such observations seem to occur about once every three or four years.”2 That is a long way from once every 10,000 years.

Consider also the following:

* From 1926-2006, twenty-three out of the eighty-one years produced negative returns. In nine of those years the losses were greater than 10 percent. In five of the years the losses exceeded 20 percent. In two of the years the losses exceeded 30 percent. And in one year the loss exceeded 40 percent. * During the same period, out of 324 quarters, there were twenty-seven in which losses exceeded 10 percent. There were also seven quarters when losses exceeded 20 percent. And there were two quarters when losses exceeded 30 percent.

What the data is telling us is that stocks are risky assets. And the risks show up fairly frequently. The data also tells us that severe losses are fairly common. In fact, the risk of severe losses is why stocks have provided higher returns historically than have bonds. On average, investors are risk averse. To entice them to take the risks of equity investing, stocks must be priced to provide high expected returns. And it is not a question of if the risks will show up. The only questions (to which no one has the answers) are when the risks will show up, how sharp the declines will be and when they will end.